Whether you’re a first-time homebuyer or a real estate aficionado, understanding how short sales work can be daunting. There are considerations for both the seller and buyer involved in a short sale, and we’ll walk through some of the finer points below.
What Is a Short Sale in Real Estate?
A “short sale” in real estate refers to the sale of a property when a homeowner is financially distressed. Due to the financial situation, the homeowner aims to sell their property for less than the amount still owed on the mortgage. When a short sale closes, the proceeds from the sale go entirely to the lender.
Depending on the state of the sale, the lender may recoup the difference owed between the balance of the mortgage and the proceeds of a short sale. In some states, the lender is legally required to forgive the difference when a short sale occurs. In other cases, the lender may choose to forgive the remaining balance or they may try to recover the difference through a deficiency judgment, which requires the homeowner to pay the lender some or all of the difference.
How Does a Short Sale Work?
Before a short sale can occur, the mortgage lender must approve the decision to attempt a short sale, which is sometimes referred to as a pre-foreclosure sale. The lender — which is often a bank — will also need documentation outlining why a short sale is the best path forward. The lender stands to lose a significant amount of money via a short sale, so lender approval is required before a short sale can occur.
What’s more, short sales are often paperwork-heavy transactions that can take a long time to process. In some cases, short sales may take up to a year to complete. Even so, a short sale may be the best financial option for a homeowner as short sales do not hurt their credit rating as much as a foreclosure would.
Pros and Cons of a Short Sale for Sellers
When a seller must consider a short sale, it is usually because it is the best option available. That said, there are some drawbacks that sellers should consider as well.
- Credit Score Impact — A short sale or pre-foreclosure sale does not have as detrimental of an impact on a person’s credit score as a foreclosure does. The latter can remain as a negative mark on a credit score for up to 7 years. As long as the homeowner is current on their mortgage payments leading up to the short sale, they may be able to apply for a new mortgage immediately.
- Fewer Fees — In a typical home sale, the seller must pay the cost of closing fees and real estate agent commissions. In a short sale, those costs are paid by the lender.
- Credit Score Damage — While the negative impact on your credit score is lesser than that of a foreclosure, a short sale can still reduce your credit score by up to 160 points.
Subject to Lender Approval — The ability to execute a short sale is dependent upon approval from your lender. This can prohibit or slow the short sale process, and there is always a chance the home could end up in foreclosure.
Considerations for Buyers in Short Sales
There are benefits and drawbacks to purchasing a short sale home that buyers should consider:
- Motivated Sellers — A short sale typically occurs because the seller is trying to avoid foreclosure. The lender is aiming to recover as much of the remaining balance on the mortgage as possible. Both parties will be diligent about approving a deal, which can work in the buyer’s favor when it comes to negotiating price.
- Fewer Buyers to Compete — Short sales are complex and can take a long time to complete, which deters many buyers from pursuing them at all. This is an advantage to buyers who are willing to buy a house via a short sale as there is less competition.
- Long Time to Close — Ultimately, the lender is in the driver’s seat of a short sale. The paperwork process is also more complex and takes much longer to complete than a traditional sale. The paperwork may take around 45 days to complete for a regular sale, while short sales may take up to four months (120 days) to complete. Any offer made must be approved by the bank, which can take months or even a year to finalize. There is also the chance that the sale could fall through if the lender determines it would make more from a foreclosure sale.
- Condition of Home — In some cases, short sale homes may be abandoned or in poor condition. Sellers should be sure to work with real estate agents seasoned in short sales as well as the proper inspection professionals.
Short Summary of the Short Sale Process
Once a seller has assessed their financial situation and determined that a short sale is the best route, several steps must occur before a short sale can be executed.
The lender must approve the short sale request: If a homeowner has determined that they will struggle to make mortgage payments going forward, they should reach out to the lender as soon as possible. A lender may be less likely to consider a short sale if you have already defaulted on your payments or can no longer continue to make payments. Be sure to speak with the correct representative at the lending institution to request a short sale approval.
Consult professionals: Upon receiving approval for a short sale, it’s time to reach out to a real estate agent, attorney, and tax professional to adequately prepare for the short sale. You will need to create a short sale proposal and begin looking for buyers, but you’ll need to be sure that you are navigating the complex short sales process appropriately. Industry professionals can help with this process.
Set the price: Since a short sale is different from a traditional home sale, pricing your home will be different. While it’s desirable to sell the home as close to market value as possible, you also need to be sure that the asking price is high enough to prevent additional financial troubles.
Create a short sale proposal: Short sales require both the standard paperwork as well as documentation that proves financial hardship to merit the short sale. This might include medical bills from a medical emergency, an unexpected job loss, or anything else that demonstrates financial hardship. The short sale proposal also requires a hardship letter where you outline the reasons you’re unable to make mortgage payments.
Find a buyer & submit a proposal: Once you’ve found a buyer, you’ll need to submit your proposal along with the buyer’s offer to the lender. If the short sale is approved, the lender will still need to approve the buyer’s offer, which can take several months. In some cases, the lender may want to negotiate with the buyer.
Both buyers and sellers involved in a short sale should consider all of their options and be sure to understand all of the ramifications of participating in a short sale. Both the benefits and drawbacks on both sides must be weighed, though your choice should ultimately depend on your unique financial situation.